The investment project of Hola-Kola, a zero calorie soft drink is being considered by

the owner of Bebida Sol, as a significant opportunity by the owner, Antonio Ortega.
A detailed evaluation has been performed for this project in order to make the final
decision.
a.      What are the relevant cash flows?
            There are many relevant cash flows for this investment project such as the
initial investment of machines, materials, labour, overhead expenses, capital
expenditures, and working capital and SG&A expenses.
 How shall we treat?
Market study cost
            The market study cost is a past cost which has been incurred before the
appraisal of the project has been performed; therefore, it is a sunk cost and should
not be considered in the investment appraisal.
Potential rental value of the unoccupied annex
            This is the opportunity lost therefore, this should be treated as a negative
cash flow as opportunity cost.
The interest charges
            The cost of financing of debt and equity is included in the weighted average
cost of capital therefore; there is no need to include them again.
Working capital
            This should be included in the appraisal. Only the incremental working
capital would be deducted.
b.      Should we consider the erosion of existing product – the regular soda – in
the analysis? Why or why not?
            Yes, the erosion of the existing product as a result of the introduction of new
zero calorie carbonates should be considered as the cannibalization cost in the
analysis as the sales of this product are going to erode the sales of the existing
products of the company, which is regular soda. Furthermore, these costs are going
to have a significant impact on the earnings of the company therefore, they should
be included in the NPV analysis.
c.       Calculate the project’s NPV, IRR, payback period, discounted payback,
and profitability index.
            The NPV of the project has been calculated to be $ -1.72 million, its IRR is
17%, payback period is 3 years and 5 months approximately, discounted payback
period is more than 5 years approximately which means never and profitability
index is almost 1. The calculations are shown in the excel spreadsheet.
d.      Perform sensitivity analyses on sales volume, price, direct labour,
materials, and energy costs. What do you observe?
            The sensitivity analysis has been performed in the excel spreadsheet and it
has been observed from the analysis that the raw material costs, labour costs, sales
revenues and other operating expenses such as the energy costs impact
significantly on the NPV of the new product. Furthermore, it is recommended for
the company to increase the selling price of the new product by 0.5 pesos.
e.       What are the “benefits” and “risks” of undertaking this project?
Benefits
            The benefits of investing in the Hola-Kola product would be increased
market share for the company. The sales of the company would also increase and
as a result, the earnings of the company would also grow. Furthermore, more
production space would be created and efficiency would be introduced in the
production processes of the company.
Risks
            The risks associated with this product are that it might cause the erosion of
the existing products of the company. The second risk is that there might not be
significant demand for this product in the market despite the findings of the market
study. Furthermore, the government might introduce new regulations regarding
soda and the competitors might also lower the prices of their products.

f.        Should Bebida Sol undertake the project? Justify

                The net present value of this project is lower and its internal rate of return
is lower than the company’s cost of capital, therefore, if the company undertakes
this project, then it is going to destroy the wealth of the shareholders. Furthermore,
the project is also sensitive to many key inputs therefore; Bebida Sol should not
undertake this project. On the other hand, Ortega needs to consider the
opportunity that had also been considered by his father, which was to venture into
the mineral water business......................
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